Banking Without Borders

When Amkor Technology acquired three semiconductor assembly and test factories in Korea last year, the West Chester, Pennsylvania-based semiconductor supplier and tester used three global banks — Citibank, Société Générale, and Deutsche Bank — to structure the $900 million deal. But because of Korea's restrictions on foreign banks, Amkor still needed the services of a local bank to transfer securities of the seller, Anam Semiconductor Inc., in which Amkor agreed to increase its investment as part of the transaction. And, says Amkor CFO Ken Joyce, the local bank's fees for the service "were high per U.S. standards."

The deal was a typical example of where U.S. companies turn for financial services as they cross more and more borders. While global banks are doing business throughout the world, they still face obstacles to competition with local banks. Last March, for instance, Malaysia released a 10-year plan to provide for the equal treatment of foreign banking competitors. But only after developing a strong set of domestic banks will the country allow nondiscriminatory treatment of foreign players already operating in the country. And only at that point will the country allow new foreigners in.

Granted, Malaysia is an extreme case. Other emerging-market countries have made great strides in opening their markets to foreign banks. But the remaining hurdles faced by outsiders are so high and widespread that more than a few U.S. companies maintain their own in-house banks to help finance their operations in certain markets.

Consider the results of a recent CFO magazine survey of top finance executives. It found that only 33 percent of those companies doing business abroad said that their major U.S. lenders provided services to them in all foreign countries, while 38 percent said some provided services and 29 percent said none did. And the reason given by those who answered "some" or "none" was that the banks were not located in those countries.

That's a situation most CFOs would clearly like to see change. By offering as full a range of products and services as possible — from cash management and custodial services to investment banking and insurance — in as many markets as possible, global banks can enjoy great economies of scope and scale, at least some of which they can be expected to pass along to their clients. Says Steven Meyer, treasurer of Baxter International, a medical products company based near Chicago, "To have to do everything with a local bank is inefficient."

Some of the limits facing foreign banks involve specific legal restrictions. Other, less direct means of inhibiting competition with local banks involve everything from red tape to poorly capitalized financial systems, unreliable legal systems, and lack of good accounting procedures.

To be sure, the extra cost such barriers impose on clients may not spell the difference between a deal's failure and success. It obviously didn't stop Amkor's Korean deal. But with profits under pressure, anything that shaves costs is something CFOs welcome. Witness the recent decision by Gateway, the personal-computer maker, to close most of its foreign operations because earnings outside the United States were insufficient. "They are giving up growth opportunities," notes Donald Young, an analyst for UBS Warburg.

Other companies in much the same boat are looking for ways to improve their global operations' profitability, and those often involve consolidating their banking relationships. One major U.S. multinational, for example, has started a pilot program to see if it can reduce its use of local banks in Southeast Asia. Most of those relationships were developed when the company, which requested anonymity, operated on a country-by-country basis. But the company has since moved to a regional and then a global approach to doing business abroad, and it would prefer to deal with banks on that basis as well. Under the test program, the company has asked a global bank to see which of the company's local banks could be replaced by Southeast Asian institutions that are part of the global bank's network of correspondent banks. Ideally, the global bank could then rationalize the company's use of local bank products and services within the region by eliminating duplication wherever feasible.

A year into the test, says the company's treasurer, the jury is still out on whether the idea will work. "Many of the relationships die hard," he says.

Enter the WTOThey would be easier to kill if expectations for negotiations at the next meeting of the World Trade Organization (WTO) are met. Next month, the United States and other developed countries will begin pushing for more financial market reforms at the new round of talks in Doha, Qatar.

On the agenda for the meeting is the following list of obstacles for foreign banks:

Restrictions on ownership of local operations. This is perhaps the biggest hurdle they face. Neither Malaysia nor China, for instance, permits foreign companies to hold a majority stake in local securities entities.

Transparency in the development and enforcement of regulation. This is a more widespread problem, and only slightly less fundamental. For starters, the application process for a banking license in many countries is unclear, and approval painfully slow. Also, emerging-market governments often fail to seek input from market participants and the public on proposed regulations, or speak only with domestic players.

Legal systems that fail to protect their interests. Equally important, banks often find a lack both of clarity of creditor rights — such as bankruptcy laws — and of enforcement muscle. "Emerging markets are slow to walk the talk," says Martyn Jones, a partner at Deloitte & Touche in the United Kingdom. "In Eastern Europe, for example, there are laws but they are not enforced." And banks cannot look to boards of directors to prevent problems, since corporate governance laws and policies are poor by U.S. standards, although pressures are mounting for improved governance.

Red tape. This can be more expensive than it seems. In Brazil, Argentina, and Colombia, for instance, "there are central bank regulations that slow the movement of capital," says Baxter's Meyer. "If you make a loan to a subsidiary, you have to register it and say how long the money will be in there." These countries still feel uncomfortable about granting foreign entities the freedom to pull capital out at their own discretion. Elsewhere, bureaucracy can effectively bar innovation. In China, says David Strongin, director of international finance for the Securities Industry Association, "a new product can take months to be approved, and derivative products are market sensitive." And in Korea, he says, currency restrictions make some derivatives difficult to structure. Red tape often also ties up a bank's ability to move key personnel. India, for instance, makes short- term assignments impractical because of laborious visa requirements.

Taxation. Banks and others gripe about the complexity or inequity of tax policies. "If you pay off a loan early, you get taxed," Meyer says.

Such obstacles stand in the way of what many corporate finance executives expect from financial institutions. Says Meyer: "We have not seen a lot of change in the last 10 years" in terms of ease in obtaining banking services and choice of products. Eastman Kodak's treasurer, William Love, adds that some markets, such as Mexico, are still "not noticeably different," despite widely hailed moves to open them to foreign competition.

There's reason for the slow progress: Numerous problems arise from lingering protectionism, lack of resources, and simply poorly developed financial systems. Although they can now be licensed in these countries, banks often run up against complications, restrictions, and poor market regulation, any of which could prevent them from operating in a sound manner.

Beyond Reach?Some problems are not easily addressed despite the best efforts of trade negotiators. Money laundering is one. In recent years, emerging markets, working with developed countries, have passed a raft of laws and regulations in a concerted effort to stop laundering and theft. "Perhaps the greatest single danger is to have exposure to money-laundering schemes," says Richard Singer, a managing director at KPMG LLP. Banks suffer with a blow to their reputation and heavy fines.

But money laundering remains a constant threat. One reason, says Singer: "In many emerging markets, where there are different cultures, it's an embarrassment to ask people for some of this data, and local employees are also embarrassed to gather it." So banks face a growing backlog of screening assignments.

Still, hope persists that better trade relations can ultimately lead to cultural change, and that the negotiations serve as a stepping-stone toward mitigating even the most intractable problems. Even without cultural change, the talks may have at least an indirect effect on some especially daunting challenges.

The biggest problem is currency. It's no secret that currencies in emerging markets are volatile; Brazil and Turkey are just two recent examples. "The currency risk has not diminished," says James Neissa, co-head of M&A in the Americas for UBS Warburg. If a bank opens a subsidiary in a developing country, it will likely be required to hold sovereign debt as reserves and to invest in local securities. And in emerging markets, currency risk is extremely difficult, and thus expensive, to hedge.

For that reason, one bank has asked KPMG to find ways to reduce its exposure to all the currencies of the emerging markets in which it conducts business. The eventual plan is to reduce such exposure through a package of derivatives instruments. But first, KPMG will have to answer such basic questions as how a representative office might offer different options than a branch office in terms of booking loans in various currencies. "We'll be required to examine local regulation as well as the tax consequences of any proposed strategy to minimize those exposures," says Singer.

That obviously would be a lot easier if there were fewer items for KPMG to study. And such obstacles mean delays for other services as well, such as structuring a hedge, managing assets, and handling complex, multicurrency transactions. "We use a lot of derivative structures to help clients accomplish things without much risk," says Neissa.

A Promising StartNone of this is to say that financial markets outside of the United States and Europe are still nothing more than protected enclaves. Indeed, earlier trade negotiations produced remarkable progress toward open markets in light of the restrictions that prevailed at the time. After all, it wasn't all that long ago that banks in many emerging markets were still controlled by local governments. Mexico is a case in point. But after privatizing its banks, the country agreed in 1993's North American Free Trade Agreement to significant measures to open its financial-services market to U.S. and Canadian players.

The WTO's Uruguay round, which went on for a good part of the mid- 1990s, represented the first time financial-services issues were addressed on a multilateral basis. The negotiations embraced the then-radical notion that to create ideal markets, there should be no discrimination between domestic and foreign competitors. Emerging- market WTO members such as Brazil, India, and the Eastern European countries made commitments to reduce discrimination against foreign banks. Eastern European markets, for instance, allowed foreign competitors the right to establish banks and branches and purchase local. Most of these countries adhered to their commitments despite the turmoil of the Asian and Russian currency crises that occurred on the heels of the agreement.

"It shows they recognized the value of a rich mix of players in their market," says Edward W. "Peter" Russell, senior vice president of government affairs-international at J.P. Morgan Chase & Co. Even WTO nonmembers China and Russia made moves to open their markets.

In fact, the crises themselves played a large role in persuading countries of the need for liberalization and for measures to strengthen their regulatory regimes. Russia has taken steps to modernize and strengthen its capital markets infrastructure by, among other things, working with foreign accounting firms like Deloitte to establish clearing and settlement organizations and transfer agents. "The lesson from the recent crises was that weak financial systems can cause and intensify a crisis," says David Lubin, HSBC's chief emerging-markets economist.

Other countries have continued to make reforms. Chile has eliminated restrictions on short-term portfolio investments and modernized protections to minority shareholders in tender offers. In Asia in particular, firms have showed growing preference for multinational banks' superior products and advice, says Glenn Wealands, a Sydney, Australia-based consultant with Greenwich Associates.

The result is more foreign bank operations in emerging markets, ranging from representative offices to subsidiaries. During the 1990s, Citibank established itself in such far-flung locales as Poland, Tanzania, and Russia. Deutsche Bank, now in 70 countries, opened a new bank in Chile last December to deliver sophisticated foreign-exchange and fixed-income products to its clients there.

The subsidiaries of more-aggressive foreign banks, such as Citibank and Spain's Banco Santander, are often domestic banks they've acquired. Most of these were distressed institutions put up for sale as part of a systemwide restructuring. Those acquisitions plus others involving foreign investors — most notably in Brazil, the Czech Republic, and Mexico in the past couple of years — have contributed to a healthy consolidation process that has created a system of stronger financial institutions.

Many banks were already in these markets, and they have enjoyed the more professional environment in many locales. "Doing business in Latin America has certainly gotten easier," remarks Neissa. With reporting and disclosure more in line with U.S. standards, "understanding a company's numbers has become a lot easier in the past decade," he says.

All of this leaves trade experts reasonably confident that the upcoming WTO meeting will produce much more progress. To be sure, the strength of political opposition to further liberalization makes it "very tough" to predict the outcome, says Morgan's Russell, who serves on the Industry Sector Advisory Committee working with the Commerce Department and the Office of the U.S. Trade Representative on services trade issues. But, he says, "a lot of good preparation has been going on, and the financial-services sector is a good example of that."

Just how far away are the competitive banking products, services, and prices that multinational clients expect everywhere they do business? "There may be one or two global banks in a market, but if there were six or eight, the intellectual capital would go up," Meyer says. "The new products they can think up" would increase in number.

But finance executives aren't holding their breath. While Kodak's Love believes that Mexico and other Latin American countries will soon change as a result of the new entrants like Banco Santander and Citibank, elsewhere, he says, "progress will continue to be slow."

Partial Progress

While banking systems in many emerging markets have consolidated, others still have a long way to go.1

'94 SHARE IN TOTAL DEPOSITS (%)

'00 SHARE IN TOTAL DEPOSITS (%)

Country

# of Banks (1994) 2

Largest 3 Banks

Largest 10 Banks

H-H Index (1994) 3

# of Banks (2000) 2

Largest 3 Banks

Largest 10 Banks

H-H Index (2000) 3

Asia

Republic of Korea4

30

52.8

86.9

1,263.6

13

43.5

77.7

899.7

Malaysia

25

44.7

78.3

918.9

10

43.4

82.2

1,005.1

Philippines

41

39.0

80.3

819.7

27

39.6

73.3

789.9

Thailand

15

47.5

83.5

1,031.7

13

41.7

79.4

854.4

Latin America

Argentina

206

39.1

73.1

756.9

113

39.8

80.7

865.7

Brazil

245

49.9

78.8

1,220.9

193

55.2

85.6

278.6

Chile

37

39.5

79.1

830.4

29

39.5

82.0

857.9

Mexico

36

48.3

80.8

1,005.4

23

56.3

94.5

1,360.5

Venezuela

43

43.9

78.6

979.2

42

46.7

75.7

923.1

Central Europe

Czech Republic

55

72.0

97.0

2,101.5

42

69.7

90.3

757.8

Hungary

40

57.9

84.7

1,578.8

39

51.5

80.7

241.2

Poland

82

52.8

86.9

1,263.6

77

43.5

77.7

899.7

Turkey

72

40.7

79.1

957.2

79

35.9

72.0

710.2

1 Analysis is based on data available as of year-end 2000 for the largest 30 banks in a specific country, including M&As; data on deposits are as of year-end 1999 or most recent available in Fitch IBCA's BankScope.2 Number of banks is based on official data provided by country authorities, the OECD, or Fitch IBCA. In Asia, the total number of banks for a specific country includes only domestic commercial banks.3 Score according to the Herfindahl-Hirschman Index, which takes the sum of the squares of the market shares of individual players in a market to measure market power. A score of 1,800 or more indicates that market concentration is high.4 Includes mergers of Kookmin and Housing & Commercial Bank and of Shinhan and Cheju Bank.

Locally incorporated banks may own insurance companies with MAS approval

Argentina

Permitted

Permitted through pension-fund affiliates

Brazil

Permitted through subsidiaries

Permitted through subsidiaries

Chile

Permitted

Insurance brokerage permitted

Mexico

Permitted through affiliates

Permitted through affiliates

Venezuela

Permitted; stock exchange activities and mutual funds

Permitted through subsidiaries, subject to controls under the insurance laws

Czech

Subject to authorization by the Republic Securities Commission

Insurance brokerage permitted

Poland

Permitted; dealing in securities through subsidiaries

Permitted

1 The chart is not intended to summarize the complete range of prudential restrictions that may apply to any such activities.2 Underwriting, dealing, and brokering all kinds of securities and all aspects of the mutual-fund business.3 Underwriting and selling insurance as principal and as agent.